South Korea Extends Stock Short-Selling Ban till 2024, Boosts Equities

South Korea’s Position on Short-Selling of Stocks

South Korea has determined to extend its prohibition on stock short-selling until June 2024. This decision triggered a notable rise in the equity market, leading to increased trading volumes.

The KOSPI, South Korea’s benchmark index, and the KOSDAQ, an index abundant with tech stocks, both experienced notable increases of 5.7% and 7.3%, respectively. This substantial growth resulted in the strongest performance for both indices since late March 2020.

Trading or hedge funds frequently use the short-selling investment strategy, in which they sell borrowed securities with the goal of buying them back later at a lower price. However, this strategy is viewed as high-risk and expensive due to the need for a margin account and collateral. It also exposes investors to potentially limitless losses due to the fact that a stock’s price can continuously rise.

The Rationale Behind Prohibition

The primary driver behind this move, according to Financial Services Commission Chairman Kim Joo-hyun, is designed to bridge the gap between institutional and retail investors. During a news conference, Kim Joo-hyun declared, “In light of ongoing financial market uncertainties, major foreign investment banks have persistently engaged in unfair trading practices, making it impossible to maintain fair trading discipline.” He further stressed that regulators will exhibit no tolerance towards illegal activities such as naked short-selling and are establishing a specialized investigation unit to prosecute violators.

The Impact of Prohibition

Notably, South Korea had previously imposed restrictions on short-selling during the COVID-19 pandemic. Although these were partially lifted in May 2021 for large-cap companies traded on KOSPI and KOSDAQ, constraints continued for over 2000 equities.

Concerns from retail investors about the effects of short-selling sparked this action, which aimed to sway public opinion prior to the National Assembly elections in April. However, exchange data shows that short-selling in South Korea constitutes a relatively minor segment of their market, amounting to roughly 0.6% of KOSPI and 1.6% of KOSDAQ.

Global Short-Selling Trends

On a related note, in the United States, the Securities and Exchange Commission (SEC) has previously implemented controversial bans on short-selling specific stocks, including a significant number of financial equities, during the 2008 financial crisis. The topic was revisited most recently during this year’s banking crisis.

Some argue that regulatory interference is occasionally necessary to shield companies and stabilize the market, which can have real-world effects like inciting fear among depositors or initiating bank runs. On the other hand, critics say that these restrictions might not only be pointless, but they might also be harmful to market quality, stability, and discovery because they might affect how liquid the market is and how well prices are set. Additionally, they claim short-sellers can sidestep these bans using other financial tools such as futures, options, and swaps.